Mortgage Daily

Published On: December 15, 2022

5/1 ARM Interest Rates Against 15-Year Mortgage Interest Rates

Generally, 5/1 adjustable-rate mortgage rates are considerably lower than 30-year fixed mortgage rates. Likewise, 5/1 ARM interest rates are often cheaper than 15-year fixed rates but by a lesser margin (generally 0.5% or less).

Keep in mind that your rate may be more or lower than the average, based on your income. credit score, debts, down payment, and other variables. 

When deciding between a 15-year fixed rate and a 5/1 ARM, you must also consider the overall interest rate environment and the amount of time you want to dwell in your new home. Here is how to select the most advantageous loan plan for you.

5/1 Adjustable-Rate Mortgage Versus a 15-Year Fixed-Rate Mortgage

Generally, adjustable mortgage rates are cheaper than fixed mortgage rates, but only during their introduction term.

The ultra-low introductory rate on a 5/1 ARM is fixed for the first five years. After then, your interest rate and monthly payment may vary annually for the remaining 25 years of the loan (or until you sell or refinance). In contrast, a 15-year fixed-rate mortgage locks your interest rate and monthly payment for the duration of the loan.

A 5/1 adjustable-rate mortgage may be preferable to a 15-year fixed-rate mortgage if you plan to relocate or refinance within five years. Thus, you can enjoy a cheaper rate and payment during the initial term of the ARM and exit the mortgage before it changes. However, if you want to remain in your home for an extended period, a 15-year fixed-rate loan may be a better option due to the financial certainty it provides.

5/1 adjustable-rate mortgages give short-term savings, but 15-year fixed-rate mortgages offer long-term protection. A 5/1 ARM can decrease your initial interest rate and monthly payment, which could help you buy a home in this expensive market, although a 15-year fixed loan has more significant amounts of better long-term savings.

Is a 5/1 ARM a Wise Choice?

A 5/1 ARM can be advantageous, but only under certain situations. There is likely no incentive to purchase a 5-year ARM when comparable or lower-rate FRMs are available. However, when ARM rates are significantly cheaper than fixed rates, a 5/1 ARM becomes considerably more attractive.

ARM Pros

  • Reduced initial rates and payments During the initial years of a 5/1 ARM, when the initial rate is fixed, you can obtain a substantially lower interest rate and lower monthly payments.
  • Reduced interest rates throughout the initial period. If you intend to sell in less than five years, a 5/1 ARM may be a prudent option. In five years, the savings from your lower rate may be sufficient to purchase a new vehicle or pay one year of college tuition.

The National Association of Realtors (NAR) estimates that property owners hold onto their homes for an average of eight years. Younger purchasers tend to leave sooner, whereas older buyers prefer to remain longer.

ARM Cons

The most significant drawback of an ARM is the possibility of interest rate increases. For example, it’s feasible that a 5/1 ARM with a 4.5% start rate may (worst case) rise as follows:

  • Beginning of year six: 6.5%
  • Starting year seven: 8.5%
  • Years eight through 30: 9.5%

This doesn’t guarantee your ARM will rise; it implies it’s conceivable.

In addition, current adjustable-rate mortgages include interest rate limits that limit the amount your rate can grow at each rate adjustment and throughout the life of the loan. And lenders sometimes approve consumers for ARMs based on the maximum feasible interest rate to guarantee that the loan remains affordable even if the rate increases.

When a 15-Year Fixed-Rate Mortgage Is Advisable

A 5/1 ARM isn’t the only option to acquire a below-market mortgage rate. Also available to homebuyers is a 15-year fixed-rate mortgage. On average, today’s 15-year fixed mortgage rates are around 0.5 percentage points higher than 5/1 adjustable mortgage rates. But they’re roughly a whole percentage point cheaper than 30-year fixed rates.

The catch? A 15-year FRM provides half as much time to pay off the loan sum as a 30-year fixed loan or a 5/1 adjustable-rate mortgage (which has a total loan term of 30 years). This implies that your monthly payments will increase however, your loan gets paid off in half the time, and luckily your mortgage payment is NOT twice as much. Not even close.

Freddie Mac’s current average rates for 30-year and 15-year FRMs were 5.89% and 5.16 respectively. Let’s examine the principle and interest monthly installments for a $300,000 loan.

  • 30-year fixed-rate mortgage: $1,780 per month
  • 15-year fixed-rate mortgage: $2,400 per month

In this instance, a 15-year fixed-rate loan costs $620 more per month than a 30-year fixed loan. However, you would save approximately $210,000 in interest over the course of the loan’s duration. In this manner, a 15-year fixed-rate mortgage can offer significant interest savings without the extra danger of variable rates and payments.

How to Pick Between a 5/1 Adjustable-Rate Mortgage and a 15-Year Fixed-Rate Mortgage

If you plan to keep your home and mortgage for only a few years, the 5/1 ARM might be a suitable choice. At least when ARM interest rates are lower than fixed rates due to market conditions. Keep in mind that if your ultimate objective is to pay off the loan as fast as possible, you always have the option of making a larger monthly payment when you can afford to do so. However, you are not obligated to make the larger payment, as you would be with a 15-year fixed-rate mortgage.

In contrast, a 15-year loan may be preferable if you expect to stay in your house for a long time and can easily handle the larger monthly payment. Before agreeing to a larger loan payment, you should review your finances and ensure you’ve completed the following:

  • Paid off all debts with the highest rates of interest.
  • Invest the maximum amount in your 401(k) if your company matches contributions.
  • Have accumulated a two-to-six-month emergency fund.

Constantly evaluate loan terms and interest rates depending on your circumstances and long-term financial goals.

High-Rate vs. Low-Rate Economy

In 2022, borrowers must reevaluate their home loan alternatives and choose which loan is optimal for their refinancing or buying. In a low-rate environment, more borrowers prefer fixed-rate loans.

For instance:

  • ARMs constituted barely 2.5% of all finalized home loans in September 2020, when rates were at historic lows.
  • Comparatively, ARMs comprised 7.2% of all completed loans in September 2018, while interest rates were still rising.

When interest rates are low across the board, the “spread” between adjustable and fixed rates is typically lower. Consequently, there is less to benefit from selecting an adjustable-rate loan. Why pick an ARM when you can lock in a nearly identical low-interest rate for the loan term?

But there are particular instances when ARM loans become more popular, generally when rates increase or when a homeowner only intends to stay in their house for a few years. (Thus, they may profit from the low fixed-rate term and relocate before their rate changes.)

How Does a 5/1 ARM Work?

A 5/1 ARM is a 30-year mortgage deal. The “5” indicates that the interest rate is set for the first five years of the loan. After then, the interest rate may adjust annually for the next 25 years, according to market conditions.

An adjustable rate implies your mortgage interest rate and payment might climb after the 5-year fixed-rate term. It is also possible for them to fall, although this is considerably less often. “It is essential to emphasize the rate change. “Many individuals just hear the phrase “pay less” and disregard the fact that the savings are only for the first five years,” notes Meyer.

That stated, a lender cannot permanently provide you with more excellent interest rates. Following “floors” and “caps,” ARM rates can only increase or decrease by a limited amount. Several variables will determine the amount of your loan’s rate adjustment:

  • The published financial index rate upon which your ARM interest rate is based.
  • The border (the sum added to your interest rate above the index rate)
  • Limits on how much a rate can increase or decrease during a single rate change.
  • Floors, which limit the rate’s ability to fall,
  • Lifetime caps (that prevent your loan’s variable interest rate from surpassing a specific threshold)

Conventionally, the beginning rate for the introduction period of a 5/1 ARM is around one percentage point lower than comparable 30-year fixed rates. However, depending on the general interest rate situation, the spread between adjustable and fixed rates might be significantly higher or smaller.

When the mortgage interest rates were at historic lows in 2020, there were moments when ARM interest rates exceeded fixed interest rates. When this occurs, it is ideal to lock in a fixed-rate loan with a highly low-interest rate that will not change in the future, even if rates rise again.

Hybrid ARMs

Prior to the property crisis of the late 2000s, homebuyers could choose some inventive ARM plans. You can obtain loans with variable monthly interest rates. Some even permitted monthly loan increases.

Today’s ARMs are significantly safer. These loans start as fixed-rate mortgages for the initial terms ranging from three to ten years. After this introductory rate expires, the remaining years are subject to an adjustable interest rate. The loans are essentially a “hybrid” of a fixed and adjustable mortgage.

Hybrid loan programs begin resetting once the promotional rate ends, but rate rises are limited by “rate caps,” so a borrower’s interest rate and monthly payment cannot rise excessively. It’s possible ARM rates might fall, but they usually climb, which means monthly mortgage payments increase too.

How 5/1 Adjustable-Rate Mortgage Rates Change

After the first fixed-rate term, ARM rates might change annually. Whether or not your ARM interest rate increases — and how much it fluctuates — depends on the rate index, it’s connected to.

Historically, most adjustable-rate mortgages were based on the 1-Year London Interbank Offered Rate (LIBOR) or the Constant Maturity Treasury (CMT) securities index. However, beginning in 2021, most ARMs will be based on the Secured Overnight Financing Rate (SOFR) index.

SOFR measures the current interest rates on the whole loan market. Your ARM interest rate is likely determined by adding a particular percentage to the SOFR overnight lending rate. This is known as the “margin.”

Suppose, for example, that your current mortgage rate is 2.5% on a 5/1 ARM, but that the end of your 5-year fixed term is quickly approaching. The current rate for overnight SOFR funding is 0.10 percent. 2.75 percent is the margin on your loan (this is typical). If your rate were to change on this day, it would increase from 2.5% to 2.85% (the index plus the margin).

If the current SOFR rate were 1.5%, your new rate would grow from 2.5% to 4.25 % in one month. Your mortgage payment may increase by several hundred dollars. When taking an ARM loan, it is vital to examine the “worst-case scenario.”

ARM Caps and Surfaces

There is more to your ARM rate than adding percentage points to its base index. There are also restrictions on how much your rate may change.

Imagine if your beginning ARM rate was 3% and it was fixed for five years. Now, your 5/1 is adapting for the first time. Consider that its terms are 2/2/5. Consequently, your interest rate:

  • It must be at most 2% during the initial adjustment.
  • Cannot exceed 2% for each subsequent modification.
  • Can never exceed a 5% increase over your initial interest rate

Your rate started at 3%, which means, which means it cannot rise over 5% for the time being. And during the life of the loan, the interest rate cannot exceed 8%.

When to Refinance Out of an Adjustable-Rate Mortgage

Recently, mortgage interest rates have increased. Suppose you presently have an adjustable-rate mortgage (ARM), and its rate fluctuates. It would help if you considered refinancing into a fixed-rate mortgage to lock in your rate and payment and prevent future rate increases.

You will have several alternatives for refinancing, including:

  • These conforming loans are governed by Freddie Mac and Fannie Mae and must adhere to lending limitations. If you have excellent credit, conventional loan rates are meager. If you have at least 20% equity when you refinance, you may be eligible to eliminate PMI. This would assist in reducing your monthly payment.
  • FHA Loans: Insured by the Federal Housing Administration, these mortgages can provide homeowners with competitive fixed rates. In most circumstances, the FHA offers a cash-out refinance option to homeowners with a minimum credit score of 600 and more than 20% home equity. You may have enough equity if you paid a higher down payment or reside in a region with rapidly appreciating property values.
  • Veterans and active-duty service members can refinance with a Department of Veterans Affairs-backed loan. A VA loan allows a homeowner to refinance up to 100 percent of the home’s value and take cash out.
  • USDA Loans: With backing from the United States Department of Agriculture, these loans are offered to rural homeowners. Approximately 97% of the nation’s landmass meets the USDA’s definition of “rural.” To qualify for USDA finance, you must also fulfill income restrictions, which state that your income cannot exceed 115% of the area’s median income.

These types of mortgages all include fixed interest rates. USDA and VA loans provide some of the lowest interest rates available, but only some are eligible.

All loan types require the homeowner to pay mortgage insurance premiums except for VA loans. You can avoid mortgage insurance if you have 20% equity in your house with a traditional mortgage. With any refinancing, you would also be required to pay closing expenses.

What Are Today’s Mortgage Rates for 5/1 and 15-Year Terms?

Rates on 5/1 adjustable-rate mortgages and 15-year fixed-rate mortgages frequently follow closely. When contacting lenders for mortgage quotes, be sure to receive figures for both programs.

Remember that mortgage rates are highly dependent on the buyer. Your credit score, debt-to-income ratio, loan length, and down payment will influence your accurate mortgage rates.

Likewise, mortgage interest rates differ per lender. Many borrowers save a substantial amount by shopping around for the lender with the lowest interest rate and costs.




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